The Economics of Solar Power

A new era for solar power is approaching. In three to seven years, unsubsidized solar could cost no more to customers in many markets than traditional energy sources like coal and gas. By 2020, global installed solar capacity could be 20 to 40 times what it is today.

A new era for solar power is approaching. The rising cost of fossil fuels and better technology is making solar, long derided as uneconomic, a major player in the future energy mix. In three to seven years, unsubsidized solar could cost no more to customers in many markets than traditional energy sources like coal and gas. By 2020, global installed solar capacity could be 20 to 40 times what it is today.

The world solar industry is entering a period of cut-throat innovation, with many new players competing for lowest-cost laurels. Rapid growth has created shortages and high margins for early solar companies. Fueled by ever-increasing flows of new equity from venture-capital and private equity firms - $3.2 billion in 2007 - innovative new competitors are entering the sector, bringing with them the potential for excess supply, falling prices and deteriorating financial performance for some time to come.

With competition heating up, companies building the equipment that generates solar power panels must relentlessly cut their costs by improving the processes they use for manufacturing solar cells, investing in research and development, and moving production to low-cost countries. Government policies will continue to heavily influence the sector's development. Deciding when and how to phase out subsidies will be critical for creating a vibrant, cost-effective sector.

Government subsidies have played a prominent role in the growth of solar power. Germany, for example, uses feed-in tariffs, which require electricity distributors to pay customers above-market rates for electricity produced from renewable sources.

Without such policies, the high cost of solar power would prevent it from competing with electricity from traditional, fossil fuel energy sources in many regions.

But the sector's economics are changing. Over the past two decades, the cost of manufacturing and installing a photovoltaic solar-power system has decreased by 20 percent. The cost of generating energy from conventional sources, by contrast, has been rising along with price of natural gas, which heavily influences electricity prices in regions that have large numbers of gas-fired power plants.

As a result, solar power has been creeping toward cost competitiveness in some areas. California, for example combines abundant sunshine with one of the highest retail rates for electricity in the United States - up to 36 cents per kilowatt hour. Solar electricity now costs 36 cents per kilowatt hour. Rising natural gas prices, regulations aiming to keep greenhouse gas emissions and therefore climate change low, and the need to build more power plants to keep up with growing demand could push the cost of conventional electricity even higher.

We forecast global solar demand by estimating the payback period for customers is different countries and regions. (Payback estimates rest on projected system costs and power prices, as well as local sunlight and incentive schemes.) Our analysis suggests that by 2020 at least ten regions worldwide will reach grid-parity with the price of solar power falling from over 30 cents per kilowatt hour to below 12, or even 10 cents.

From now until 2020, installed global solar capacity will grow by 30 to 35 percent a year, from 10 gigawatts today to about 200-400 gigawatts, requiring capital investments of $500 billion. Even though this volume only represents 1.5 to 3 percent of global electricity output, this capacity would provide 10 to 20 percent of annual new power capacity over that period. This level of solar energy use would abate some 125 to 250 megatons of carbon dioxide emissions.

The extent and speed of this diverse and complex sector's emerging growth will depend on continuing to drive down the cost of solar power. No single player or group of players can make this happen alone.

The necessary technological breakthroughs will come from solar component manufacturers, but rapid progress depends on robust demand from end users, to whom manufacturers have only limited access.

Utilities have strong relationships with residential, commercial, and industrial customers and understand the economics of serving them. But these companies will have difficulty driving the penetration of solar power unless they have a much clearer sense of the cost potential of different solar technologies.

In some regions, regulators can accelerate the move towards grid parity, as they did in California and Germany, but they can't reduce the real cost of solar power. Poor regulation may even slow the fall in prices.

The fundamentals are clear for photovoltaic-component manufacturers that hope to remain competitive: there's no escaping significant R&D investments to stimulate continued efficiency improvements, as well as operational excellence to drive down manufacturing costs. Furthermore, in view of ongoing technological uncertainty, established silicon-wafer-based solar cell manufacturers should hedge their bets by investing in advancing thin-film technology.

Utilities are in a good position to integrate solar electricity generated at large numbers of different locations (like rooftop solar arrays) into the network. Many utilities could use their advanced metering infrastructure to calculate the full value of solar power usage during peak times.

The technology that currently seems most attractive to utilities is concentrated solar thermal power, because it involves centralized electricity generation - much as traditional coal, nuclear and hydroelectric facilities do - and is today's low-cost solar champion. Its long term prospects though, are less favorable than some other emerging photovoltaic technologies, so choosing it now id in effect a strategic bet on how quickly relative costs and local subsidies will change.

The decisions of regulators will affect not only utilities but the entire solar sector. For solar power to successfully reach grid parity, well-understood and targeted subsidy schemes will be essential to building the confidence of investors and attract capital. All government regulation of the solar sector should focus on a few major factors.

- Clarify objectives. Before establishing policies, regulators must decide whether they want to increase energy security, lower greenhouse emissions, create jobs, or any combination of these goals.

- Reward production, not capacity. Subsidizing capacity rewards all solar power installations at the same rate, regardless of cost-efficiency. Production-based subsidies, which reward companies only for generating electricity, create incentives to reduce costs and to focus initially on attractive areas with strong sunlight.

- Phase out subsidies carefully. In virtually every region of the world, solar subsidies are still crucial to the industry. But since solar power could eventually be cost competitive with conventional sources, regulators must adjust incentive structures over time and phase them out when grid parity is reached.

Solar energy is becoming more economically attractive. Component manufacturers, utilities and regulators are making decisions now that will determine the scale, structure and performance of this new sector. Technological uncertainty makes the choices difficult, but the opportunities - for companies to profit and for a world less dependant of fossil fuels - are significant.

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